What Happens When You Inherit an Already Inherited IRA?
When you are the successor beneficiary of an Inherited IRA the rules are very complex.
When someone passes away and they have a retirement account, if there are non-spouse beneficiaries listed on the account, they will typically rollover the balance in the inherited retirement account to either an Inherited Traditional IRA or Inherited Roth IRA. But what happens when the original beneficiary passes away and there is still a balance remaining in that inherited IRA account? The answer is that a successor beneficiary inherits the account, and then the distribution rules become complex very quickly.
Beneficiary of an Inherited IRA (Successor Beneficiaries)
As a beneficiary of an inherited IRA, it's important to understand that the options available to you for taking distributions for the account will be determined by the distribution options that were available to the original beneficiary of the retirement account that you inherited it from, which vary from beneficiary to beneficiary.
Non-spouse Inherited IRA Rule
The IRS changed the rules for non-spouse beneficiaries back in 2019 with the passing of the Secure Act, which put original non-spouse beneficiaries in two camps: beneficiaries that inherited a retirement account from someone that passed away prior to January 1, 2020, and beneficiaries that inherited retirement accounts some someone that passed January 1, 2020 or later.
We have a whole article dedicated to these new non-spouse beneficiary rules that can be found on our website but for now I will move forward with the cliff notes version.
Stretch Rule vs 10-Year Rule Beneficiaries
As the beneficiary of an inherited IRA, you must be able to answer two questions:
Was the original beneficiary subject to the “RMD stretch rule” or “10-year rule”?
If that beneficiary was required to take an RMD in the year they passed, did they already distribute the full amount?
Original Beneficiary was the Spouse
A common situation is that a child has two parents - the first parent passes away, and the balance in those retirement accounts are then inherited by the surviving spouse and moved into the surviving spouse’s own retirement accounts. A spouse of an original owner of a retirement account has special rules available to them which allow them to roll their deceased spouse’s retirement accounts into their own retirement accounts and treat them as their own. When their children inherited the remaining balance in the retirement accounts from the second to parent, they are considered non spouse beneficiaries and are most likely subject to the new 10-year distribution rule unless they qualify for an exception.
Non-spouse Beneficiary 10-Year Rule
If the original beneficiary of the Inherited IRA received that account from someone that passed away after December 31, 2019 and they are a non-spouse beneficiary, they are most likely subject to the new 10-Year Rule which requires the original beneficiary to fully deplete that retirement within 10 year of the year following the original decedent’s death.
Example: Sue, the original owner of a Traditional IRA passes away in 2022, and her daughter Katie is the sole beneficiary of her IRA. Since Katie is a non-spouse beneficiary, she would be required to fully deplete the IRA by 2032, 10 years following the year after that Sue passed away.
But what happens if Katie, the original beneficiary of that inherited IRA passes away in 2026, and she is only 4 years into the 10-year depletion cycle? In this example, when Katie set up her inherited IRA, she named her two children Scott & Mara as 50/50 beneficiary on her inherited IRA account. Scott and Mara would move their respective 50% balance into their own inherited IRA account but as beneficiaries of an already inherited IRA, the 10-year rule does not reset. Scott & Mara would be bound to the same 10-year depletion date that Katie was subject to so Scott & Mara would have to deplete the Inherited IRA (2 times inherited) by 2032 which was Katie’s original 10-year depletion date.
10-Year Rule: The basic rule is if the original beneficiary of the inherited IRA was subject to the 10-year rule, as the new beneficiary of that existing inherited IRA, you get whatever time is remaining in that original 10-year period to fully deplete that Inherited IRA. It does not matter whether the inherited IRA that you inherited was a Traditional IRA or a Roth IRA, the same rules apply.
Original Beneficiary was a “Stretch Rule” beneficiary or the Spouse
For original non-spouse beneficiaries that inherited the retirement account from an account owner that passed away before January 1st, 2020, they have access to what is called the Stretch Rule. Those non-spouse beneficiaries are allowed to move the original owners balance of the retirement account to their own inherited IRA and they are not required to deplete the account in 10 years.
Instead, those non-spouse beneficiaries are only required to take an annual RMD (required minimum distribution) each year, which are small distributions from the Inherited IRA each year, but they could effectively stretch the existence of that inherited account over their lifetime. But it’s also important to note, that some non-spouse beneficiaries that inherited a retirement account from someone who passes on or after January 1, 2020, may have qualified for a stretch rule exception which are as follows:
Surviving spouse
Person less than 10 years younger than the decedent
Minor children
Disabled person
Chronically ill person
Some See-Through Trusts benefitting someone on this exception list
If the original beneficiary of the inherited IRA was eligible for the stretch rule, and you inherited that inherited IRA from that individual, you would NOT be eligible for the Stretch Rule, you would be subject to the 10-year rule, but you would have a full 10-years after the owner of that inherited IRA passes away to fully deplete the balance in that inherited IRA that you inherited.
When we are talking about beneficiaries of an already inherited IRA, it does not matter whether you were their spouse or non-spouse because the spouse exceptions only apply to the spouse of the original decedent.
Example: John inherited a Traditional IRA from his father who passed away in 2018. John was a non-spouse beneficiary, but since his father passed before 2020, he was eligible for the stretch provision which allowed John to roll over the Traditional IRA to an inherited IRA in his name and he was only required to take annual RMD’s each year but was not required to deplete the account in 10 years. John passes in 2025, his daughter Sarah is the beneficiary of the Inherited IRA, since Sarah inherited the inherited IRA from John who passes after December 31, 2019, Sarah would be required to deplete the balance in John’s inherited IRA by 2035, 10-year following the year after John passes.
RMD of Beneficiaries of Inherited IRAs
Now we have to move on to the second question that beneficiaries of Inherited IRAs need to ask, which is “does the successor beneficiary of an inherited IRA need to take annual RMD’s from the account each year?” The answer is “it depends”.
It’s common for beneficiaries of Inherited IRAs to be subject to both the 10-year rule and be required to take annual required minimum distributions from the account. Whether or not the beneficiary needs to take an RMD will depend on the whether or not the original beneficiary of the account was required to take RMDs. The basic rule is if the current owner of the Inherited IRA was required to take annual RMD’s from the account, you as the beneficiary of the Inherited will be required to continue to take RMD’s from the account. The IRS has a rule that once an owner of an IRA or Inherited IRA has started taking RMDs, they cannot be stopped.
If the answer is “Yes:”, the person that you inherited the Inherited IRA from was already taking RMD’s from the Inherited IRA account, then you as the beneficiary of that inherited IRA would be subject to whatever time is left in the 10-year rule, and you would also be required to take RMDs from the account each year.
Don’t Forget To Take The Decedent’s RMD
RMD’s are usually required to begin the year after an individual passes away which is true of Inherited IRAs but as the beneficiary of an retirement account, where the decedent was required to take an RMD for that year, you have to ask the question: did they satisfy their RMD requirement before they passed away.
If the answer is “yes”, no action is required in the year that they passed away unless they were in year 10 year of the depletion cycle.
If the answer is “no”, then you as the beneficiary of that existing Inherited IRA are required to take the undistributed RMD amount from that inherited IRA in the year that the decedent passed away.
Example: Kelly inherits an Inherited IRA from her mother Linda. Linda originally inherited the IRA from her father when he passed in 2022. At the time that her father passed, he was 80, which made him subject to RMDs. When Linda inherited the account from her father, since he was subject to RMDs, Linda was subject to the 10-year rule and annual RMDs. Linda passed in 2024, her daughter Kelly inherits her Inherited IRA, and Kelly would be required to fully deplete the inherited IRA by 2032 (Linda original 10 year rule date), she would be required to take annual RMD’s from the account because Linda was receiving RMDs, and if Linda did not receive her full RMD in 2024 when she passed, Kelly would have to distribute any amount that Linda would have been required to take in the year that she passes.
A lot of rules, but all very important to avoid the IRS penalties that await the taxpayers that fail to take the proper RMD amount or fail to adhere to the new 10-year rule.
Summary of 3 Successor IRA Questions
When you are the beneficiary of an inherited IRA, you must be able to answer the following questions:
Was the person that you inherited the inherited IRA from subject to the 10-year rule?
Was the person that you inherited the Inherited IRA from required to take annual RMDs?
Did the decedent take their RMD before they passed?
What was the age of the decedent when that passed?
The last question is important because there are potential situations where someone is the original beneficiary of an Inherited IRA subject to the 10-year rule, based on the age of the original owner when they passed and the age when the original beneficiary when they inherited the IRA may not make them subject to the annual RMD requirement. However, if the original beneficiary passes away after their “Required Beginning Date” for RMDs, the beneficiary of that inherited IRA may be subject to an annual RMD requirements even though the original beneficiary was not.
The IRS has unfortunately made the rules very complex for beneficiaries of an Inherited IRA account, so I would strongly recommend consulting with a professional to make sure you fully understand the rules.
General Rules Successor IRA Rules
If you are a successor beneficiary:
If the owner on the inherited IRA was subject to the stretch rule, you as the successor beneficiary are now subject to the 10-year rule
If the owner of the Inherited IRA was subject to the 10-year rule, you have whatever time is remaining within that original 10 year window to deplete the account balance.
Whether or not you have to take an RMD in the year they pass and in future years, is more complex, seek help from a professional.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
The Final Rules For Non-spouse Beneficiary Inherited IRAs Has Been Released: The 10-Year Rule, Annual RMD Requirement, Tax Strategies, New 401(k) Roth Rules, and More…….
In July 2024, the IRS released its long-awaited final regulations clarifying the annual RMD (required minimum distribution) rules for non-spouse beneficiaries of retirement accounts that are subject to the new 10-year rule. But like most IRS regulations, it’s anything but simple and straightforward.
In July 2024, the IRS released its long-awaited final regulations clarifying the annual RMD (required minimum distribution) rules for non-spouse beneficiaries of retirement accounts that are subject to the new 10-year rule. But like most IRS regulations, it’s anything but simple and straightforward. The short answer is for non-spouse beneficiaries that are subject to the 10-year rule; some beneficiaries will be required to begin taking annual RMDs starting in 2025 while others will not. In this article, we will review:
The RMD requirement for non-spouse beneficiaries
RMD start date
IRS penalty relief for missed RMDs
Are one-time distributions required for missed RMDs 2020 - 2024?
Different RMD rules for Traditional IRAs versus Roth IRAs
Different RMD rules for Roth 401(k) versus Roth IRAs
Common RMD mistake for stretch rule beneficiaries
In addition to covering the topics above related to the new RMD rules, we want this article to be a “one-stop shop” for non-spouse beneficiaries to understand how these non-spouse inherited IRAs work from start to finish, so we will start this article by covering:
How Inherited IRA work for non-spouse beneficiaries
Rules for a decedent that pass either before or after 2019
The new 10-year Rule
Beneficiaries that are granted an exception to the new 10-year rule
Required minimum distributions (RMDs)
Taxation of distributions from inherited IRAs
Tax strategies and Pitfalls associated with Inherited IRA accounts
Special rules for minor children with Inherited IRAs
(If you are reading this just for the new RMD rules, you can skip to the second half of the article)
Non-spouse Beneficiaries of Retirement Accounts
When you inherit a retirement account, there are different options available to you depending on whether you are a “spouse beneficiary” or a “non-spouse beneficiary”. In this article, we are going to be focusing on the options available to a non-spouse beneficiary.
Non-spouse Beneficiary Rules Prior to 2020
In 2019, the SECURE Act 1.0 was passed, which greatly limited the inherited IRA options that were available to non-spouse beneficiaries of IRAs, 401(k)’s, and other types of employer-sponsored retirement plans. Under the old rules, if someone passed away prior to January 1, 2020, you as a non-spouse beneficiary, were allowed to move the balance of that IRA into an inherited IRA in your name, avoid any immediate tax implications, and you only had to take small distributions each year called RMDs (required minimum distributions) based on IRS life expectancy table. This was called the “stretch rule” which allowed a non-spouse beneficiary to stretch the distributions over their lifetime.
If you wanted to take more out of the account, you could, since it’s an inherited IRA, even if you were under the age of 59 ½, you avoided the 10% early withdrawal penalty and either had to pay income tax on a pre-tax retirement account or avoided tax altogether on Roth inherited IRA accounts. These beneficiaries had a lot of flexibility with this option with minimal emergency tax planning needed.
For individuals in this camp who inherited a retirement account from someone who passed away prior to January 1, 2020, the good news is you are grandfathered in under the old rules, and none of the changes that we are going to cover in this article apply to you. You still have access to the stretch provision.
Non-spouse Beneficiary of Decedent That Passed After December 31, 2019
SECURE Act 1.0, which passed in 2019, took away the “stretch option” for most non-spouse beneficiaries and replaced it with a much more restrictive “10-Year Rule,” which requires a non-spouse beneficiary to fully deplete the account balance of that inherited retirement account within 10 years start the year after the decedent passed away. If you inherited a retirement account from someone who passed away AFTER December 31, 2019, and you are non-spouse beneficiaries, you are subject to the new 10-Year Rule UNLESS you meet one of the exceptions. Non-spouse beneficiaries that qualify for an exception to the 10-year rule are referred to as “Eligible Designated Beneficiaries” in the new tax regulations if you choose to read the 260 pages that were just released by the IRS.
Here is the list of beneficiaries that are exempt from the new 10-year rule and still have the stretch option available to them:
Surviving spouse
Person less than 10 years younger than the decedent
Minor children
Disabled person
Chronically ill person
Some See-Through Trusts benefitting someone on this exception list
Non-Spouse Beneficiary Not More Than 10 Years Younger Than The Decedent
I wanted to highlight this exception because it’s the most common exception to the 10-rule for non-spouse beneficiaries that we see amongst our clients. If you are a non-spouse beneficiary of a retirement account from someone that was not more than 10 years younger than you like a sibling or a cousin, the new 10-year distribution rule does not apply to you. You are allowed to roll over the balance to your own inherited IRA and stretch annual RMDs over your lifetime.
Example: Tim passes away at the age of 55 and his sister Susan age 58 is the 100% primary beneficiary of his Traditional IRA account, since Susan is a non-spouse beneficiary, she normally would be subject to the 10-year rule requiring her to fully distribute and pay tax on Tim’s IRA balance within a 10 year period. However, since Tim was less than 10 years younger than Susan, she qualifies for the exception to the 10-year rule. She can rollover Tim’s IRA balance into an Inherited IRA in her name, and she would only be required to take small required minimum distributions each year starting the year after Tim passed away.
Minor Children As Beneficiary of Retirement Accounts
The minor child exception is a little tricker. If a minor child is the beneficiary of a retirement account, and they inherited the retirement account from their parents, they are only required to take those small annual RMDs until they reach age 21, but then as soon as they turn 21, they switch over to the 10-Year Rule. If they inherited the retirement account from someone other than their parent, then the 10-year period begins the year after the decedent passes away like the rest of the non-spouse beneficiaries.
Example: Josh is age 12 and his mother unexpectedly passes away and Josh is listed as the primary beneficiary on his mother’s 401(K) account at work. Josh, as a non-spouse beneficiary, would not immediately be subject to the 10-year rule, but instead, he would be temporarily allowed to use the stretch provision; he would be required to take annual RMDs each year from the retirement account until he reaches age 21. Once Josh reaches age 21, he will then be subject to the 10-year rule, and he will be required to fully distribute the retirement account 10 years following when he turns age 21.
Age of Majority: Normally the “age of majority” is defined by the state that the minor lives in. For some states, it’s age 18, and in other states, it’s age 21. The new IRS regulations addressed this issue and stated that regardless of the age of majority for the state that the minor lives in and regardless of whether or not the child is a student past the age of 18, the age of majority for purposes of triggering the 10-year rule for non-spouse beneficiaries will be age 21.
Non-Spouse Beneficiary Subject To The 10-Year Rule
If you are a non-spouse beneficiary who inherited a retirement account from someone who passed away AFTER December 31, 2019, and you DO NOT qualify for one of the exceptions previously listed, then you are subject to the new “10-Year Rule”. The 10-Year Rule requires a non-spouse beneficiary to fully deplete the inherited retirement account balance no later than 10 years following the year after the decedent passes away.
The 10-Year Rule Applies to Both Pre-Tax and Roth Retirement Accounts
Regardless of whether you inherited a pre-tax retirement account like a Traditional IRA, SEP IRA, or 401(k) account or a Roth retirement account like a Roth IRA or Roth 401(k), the 10-year rule applies.
Example: Sarah’s father just passed away in February 2024, and she was the 100% primary beneficiary of his Traditional IRA account with a balance of $300,000. Sarah is age 60. Sarah, as a non-spouse beneficiary, would be subject to the 10-year rule and would be required to fully distribute and pay tax on the full $300,000 before December 31, 2034, which is 10 years following the year after her father passed away.
The RMD Mystery
When the 10-Year Rule first came into being in 2020, it was assumed that this 10-year rule was an extension of the previous “5-year rule”, which only required the beneficiary to deplete the account balance within 5 years but there was no annual RMDs requirement during that 5-year period. The IRS just simply eliminated the “stretch option” and extended the 5-year rule to a 10-year rule.
But then, two after the IRS passed SECURE Act 1.0 with this new 10-year rule, the IRS came out with new proposed regulations that basically said, “Whoops, I know we wrote it that way, but that’s not what we meant.”
In the proposed regulations that the IRS released in February 2022, the IRS clarified that what they meant to say was that certain non-spouse beneficiaries that are subject to the new 10-year rule would ALSO be required to take annual RMDs during that 10-year period. This was not welcome news for many non-spouse beneficiaries, and it created a lot of confusion since a few years had already gone by since the new 10-year rule was signed into law.
The New RMD Rules for Inherited IRA for Non-spouse Beneficiaries
The finalized IRS regulations that were just released in July 2024 made their stance official. Whether or not a non-spouse beneficiary will be subject to BOTH the 10-Year Rule and annual RMDs will be dependent on two factors:
The age of the decedent when they passed away
The type of retirement account that the beneficiary inherited (Pre-tax or Roth)
RMD Requirement Based on Age of Decedent
If you are the original owner of a retirement account (Traditional IRA, 401(k), etc.), once you reach a specific age, the IRS requires you to start taking small distributions from that pre-tax account each year, which are called required minimum distributions (RMDs).
The age at which you are required to begin taking RMDs is called your Required Beginning Date (“RBD”), not to be confused with the “RMD”. There are too many acronyms in the finance world “The IRS wants you to take your RMD by your RBD ASAP so they can collect their TAX.”
The date at which RMDs are required to begin varies based on your date of birth:
Born 1950 or earlier: Age 72
Born 1951 – 1959: Age 73
Born 1960 or later: Age 75
Someone that is born in 1956 would be required to start taking RMDs from their pre-tax retirement accounts at age 73. Why is this relevant to non-spouse beneficiaries? Because whether or not the decedent died before or after their Required Beginning Date for RMDs will determine whether or not you, as the non-spouse beneficiary, are required to take annual RMDs during the 10-Year Rule period.
The Decedent Passes Away Prior to Their RMD Required Beginning Date
If the decedent passed away prior to their Required Beginning Date, then you, as the non-spouse beneficiary, are subject to the 10-Year Rule, but you ARE NOT REQUIRED to take annual RMDs during the 10-year period. You simply have to deplete the account balance prior to the end of the 10 years.
Example: Brad’s father passes away at age 68 and Brad is the 100% beneficiary of his Traditional IRA. Brad’s father was born in 1956, making his RMD start at age 73. Since Brad’s father passed away prior to reaching age 73 (RBD), Brad would be subject to the 10-year rule but would not be required to take annual RMDs during that 10-year period.
The Decedent Passes Away After Their RMD Required Beginning Date
If the decedent passes away AFTER their Required Beginning Date for RMDs, then the non-spouse beneficiary is subject to BOTH the 10-year rule AND is required to take annual RMDs during that 10-year period.
Example: Dave’s father passed away at age 80, and he had been taking RMDs for many years since he was beyond his Required Beginning Date. When Dave inherits his father’s Traditional IRA, he will not only be subject to the 10-year rule as a non-spouse beneficiary, but he will also be required to distribute annual RMDs every year from the Inherited IRA account since his father had already begun receiving RMDs for his account.
RMDs Not Required Until 2025
Since the IRS just released the final regulation in July 2024, for non-spouse beneficiaries that are subject to both the 10-Year Rule and annual RMDs, RMDs are not required to begin until 2025.
Good news: For non-spouse beneficiaries subject to the 10-year rule, the IRS has waived all penalties for the “missed RMDs” between 2020 and 2024, and they are not requiring these non-spouse beneficiaries to “make up” for missed RMDs for years leading up to 2025. The RMDs will be calculated in 2025 like everything has been working smoothly since Day 1.
No Reset of the 10-Year Depletion Timeline
It’s important to note that even though the IRS took 4 years to clarify the RMD rules associated with the new 10-year rule, it does not reset the 10-year clock for the depletion of the inherited retirement account.
Example: Jessica’s uncle passed away in 2020 at the age of 82. Jessica, as a non-spouse beneficiary, would be subject to the 10-year rule requiring her to fully deplete the Traditional IRA by December 31, 2030. Since her uncle was past his Required Beginning Date for RMDs, Jessica would be required to take annual RMD in the years 2025 – 2030. (Note that the 2021 – 2024 RMDs were waived due to the IRS delay). Even though her first RMD will not be until 2025, she is still required to deplete the Traditional IRA account by December 31, 2030.
Annual RMD Rules
Many of these examples incorporate the delay in annual RMDs due to the delay in the IRS regulations being released. However, if someone passes away in 2024 and has a non-spouse beneficiary listed on their pre-tax retirement account, the 10-year timeline and the first annual RMD calendar would begin in 2025, which is the year following the decedent’s date of death.
The first RMD is required to be taken by a non-spouse beneficiary by December 31st of the year following the decedent's death.
Inherited Roth IRAs – No RMD Requirement
You will notice in most of my examples that I specifically use a “Traditional IRA” or “Pre-tax Retirement Account.” That is because only pre-tax retirement accounts have the RMD requirement. If you are the original owner of a Roth IRA, Roth IRAs do not require you to take an RMD regardless of your age. So, under the new rules, if you inherit a Roth IRA, since the decedent would not have been required to take an RMD from a Roth IRA at any age, they never had a “Required Beginning Date”. This makes the non-spouse beneficiary subject to the 10-year rule, but no annual RMDs would be required from an inherited Roth IRA.
Note: If you inherit a Roth IRA and you are eligible for the stretch options, annual RMDs are then required from you Inherited Roth IRA account.
Roth 401(k)s Are Different
While typically, Roth IRAs and Roth 401(k)s have the same rules, the IRS included a weird rule for Roth 401(k)s in the final regulations regarding the RMD requirement. If you inherit a 401(k) plan, it’s possible that there are both Pre-tax and Roth monies within that same account since most 401(k) plans allow plan participants to make either pre-tax deferrals or Roth deferrals to the plan.
Normally I would have thought if a 401(k) account contains both Pre-tax and Roth dollars, as a non-spouse beneficiary, you would have the 10-year rule for the full account balance, but you could ignore the RMD requirement for the Roth dollars, but the annual RMDs on the pre-tax portion of the account would depend on whether or not the decedent passed away before or after their Required Beginning Date for RMDs. Assuming this, I would have been correct for the pre-tax portion of the 401(k) account but potentially wrong about no annual RMDs for the Roth portion of the 401(k) account.
The final regulations state that if the 401(k) account contains ONLY Roth dollars, no pre-tax dollars within the account, then a non-spouse beneficiary is subject to the 10-year rule but DOES NOT have to take annual RMDs during that 10-year period.
However, if the 401(k) account contains both Roth and any other type of pre-tax source, like employee pre-tax deferrals, employer match, and employer profit sharing, which is much more common for 401(k) plans, then the ENTIRE BALANCE in the 401(k) plan, INCLUDING THE ROTH SOURCE, is subject to the annual RMD requirement during the 10-year period. Yuck!!!
This new rule will encourage individuals who have a Roth source within their employer-sponsored retirement plans to roll over their Roth monies within the plan to a Roth IRA before they pass away. By removing that Roth source from the employer-sponsored retirement plans and moving it into a Roth IRA, now when the non-spouse beneficiary inherits the Roth IRA, they are allowed to accumulate those Roth dollars longer within the 10-year period since they are not required to take annual RMDs from a Roth IRA account.
Note: The pre-tax sources within a 401(k) works the same way as inheriting a Traditional IRA. A non-spouse beneficiary would be subject to the 10-year rule and may or may not have to take RMDs during the 10-year period depending on whether or not the decedent dies before or after their Required Beginning Date for RMDs.
Non-Spouse Beneficiaries Eligible For The Stretch Rule Only Had An RMD Waiver for 2020
In 2020, part of the COVID relief packages was the ability to waive taking an RMD during that calendar year. I have run into a few cases where non-spouse beneficiaries that were grandfathered in under the “stretch rules” requiring them to take an annual RMD each year, are getting confused with the delay in the RMD requirement for non-spouse beneficiaries that are subject to the new 10-year rule after December 2019. The delay in the annual RMDs until 2025 for non-spouse beneficiaries ONLY applies to individuals subject to the 10-year rule. If you inherited a retirement account from someone who passed away prior to 2020 or you qualify for one of the exceptions to the 10-Year Rule as a non-spouse beneficiary, you are grandfathered in under the old “Stretch Rule,” which requires the owner of that Inherited IRA to take annual RMD’s from that account each year starting in the calendar year following the decedent’s date of death.
In summary, if you are a stretch rule non-spouse beneficiary, the only year you were allowed to skip your RMD was 2020 per the COVID relief; you should have restarted your annual RMDs in 2021 and taken an RMD for 2021, 2022, and 2023, and subsequent years. If you missed this, the good news is the Secure Act 2.0 also lowered the IRS penalty amount for missed RMDs, from 50% to 25% and even lower to 10% if timely corrected.
Non-Spouse Inherited IRA Tax Strategies
We will be writing a separate article that contains all of the advanced tax strategies that we implement for clients who are non-spouse beneficiaries subject to the 10-year rule since there are a number of them, but here is some of the standard guidance that we provide to our clients.
If you inherit a Roth IRA, that is an ideal situation because even though you are subject to the 10-year rule as a non-spouse beneficiary, all of the accumulation in an Inherited Roth IRA can be withdrawn tax-free.
Example: John inherits a $200,000 Roth IRA from his mother in 2024. John, as a non-spouse beneficiary, will be subject to the 10-year rule, so the account has to be depleted by 2034, but he is not required to take annual RMDs because it’s a Roth IRA account. If John invests the $200,000 wisely and receives an 8% annual rate of return, at the end of 10-year the $200,000 has grown to $431,785 within that Inherited Roth IRA, and the full balance will be distributed to him ALL TAX-FREE.
For this reason, we have a lot more clients processing Roth Conversions in retirement to push more of their net worth from the pre-tax bucket over to the Roth bucket, which is much more favorable for non-spouse beneficiaries when they inherit the account.
For clients that inherit larger pre-tax retirement accounts that are subject to the 10-year rule, we have to develop a detailed tax plan for the next 10 years since we know all of that money will need to be distributed and taxed within the next 10 years, which could cause the money to be taxed at a higher tax rate, increased Medicare premiums, lower financial aid awards for parents with kids in college, have their social security taxed at a higher rate, lose tax deductions, or other negative consequences for showing too much income in a single year.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
2023 RMDs Waived for Non-spouse Beneficiaries Subject To The 10-Year Rule
There has been a lot of confusion surrounding the required minimum distribution (RMD) rules for non-spouse, beneficiaries that inherited IRAs and 401(k) accounts subject to the new 10 Year Rule. This has left many non-spouse beneficiaries questioning whether or not they are required to take an RMD from their inherited retirement account prior to December 31, 2023. Here is the timeline of events leading up to that answer
There has been a lot of confusion surrounding the required minimum distribution (RMD) rules for non-spouse beneficiaries who inherited IRAs and 401(k) accounts subject to the new 10-Year Rule. This has left many non-spouse beneficiaries questioning whether or not they are required to take an RMD from their inherited retirement account prior to December 31, 2023. Here is the timeline of events leading up to that answer:
December 2019: Secure Act 1.0
In December 2019, Congress passed the Secure Act 1.0 into law, which contained a major shift in the distribution options for non-spouse beneficiaries of retirement accounts. Prior to the passing of Secure Act 1.0, non-spouse beneficiaries were allowed to move these inherited retirement accounts into an inherited IRA in their name, and then take small, annual distributions over their lifetime. This was referred to as the “stretch option” since beneficiaries could keep the retirement account intact and stretch those small required minimum distributions over their lifetime.
Secure Act 1.0 eliminated the stretch option for non-spouse beneficiaries who inherited retirement accounts for anyone who passed away after December 31, 2019. The stretch option was replaced with a much less favorable 10-year distribution rule. This new 10-year rule required non-spouse beneficiaries to fully deplete the inherited retirement account 10 years following the original account owner’s death. However, it was originally interpreted as an extension of the existing 5-year rule, which would not require the non-spouse beneficiary to take annual RMD, but rather, the account balance just had to be fully distributed by the end of that 10-year period.
2022: The IRS Adds RMDs to the 10-Year Rule
In February 2022, the Treasury Department issued proposed regulations changing the interpretation of the 10-year rule. In the proposed regulations the IRS clarified that RMDs would be required for select non-spouse beneficiaries subject to the 10-year rule, depending on the decedent’s age when they passed away. Making some non-spouse beneficiaries subject to the 10-year rule with no RMDs and others subject to the 10-year rule with annual RMDs.
Why the change? The IRS has a rule within the current tax law that states that once required minimum distributions have begun for an owner of a retirement account the account must be depleted, at least as rapidly as a decedent would have, if they were still alive. The 10-year rule with no RMD requirement would then violate that current tax law because an account owner could be 80 years old, subject to annual RMDs, then they pass away, their non-spouse beneficiary inherits the account, and the beneficiary could voluntarily decide not to take any RMDs, and fully deplete the account in year 10 in accordance with the new 10-year rule. So, technically, stopping the RMDs would be a violation of the current tax law despite the account having to be fully depleted within 10 years.
In the proposed guidance, the IRS clarified, that if the account owner had already reached their “Required Beginning Date” (RBD) for required minimum distributions (RMD) while they were still alive, if a non-spouse beneficiary, inherits that retirement account, they would be subject to both the 10-year rule and the annual RMD requirement.
However, if the original owner of the IRA or 401k passes away prior to their Required Beginning Date for RMDs since the RMDs never began if a non-spouse beneficiary inherits the account, they would still be required to deplete the account within 10 years but would not be required to take annual RMDs from the account.
Let’s look at some examples. Jim is age 80 and has $400,000 in a traditional IRA, and his son Jason is the 100% primary beneficiary of the account. Jim passed away in May 2023. Since Jason is a non-spouse beneficiary, he would be subject to the 10-year rule, meaning he would have to fully deplete the account by year 10 following the year of Jim’s death. Since Jim was age 80, he would have already reached his RMD start date, requiring him to take an RMD each year while he was still alive, this in turn would then require Jason to continue those annual RMDs during that 10-year period. Jason’s first RMD from the inherited IRA account would need to be taken in 2024 which is the year following Jim’s death.
Now, let’s keep everything the same except for Jim’s age when he passes away. In this example, Jim passes away at age 63, which is prior to his RMD required beginning date. Now Jason inherits the IRA, he is still subject to the 10-year rule, but he is no longer required to take RMDs during that 10-year period since Jim had not reached his RMD required beginning date at the time that he passed.
As you can see in these examples, the determination as to whether or not a non-spouse beneficiary is subject to the mandatory RMD requirement during the 10-year period is the age of the decedent when they pass away.
No Final IRS Regs Until 2024
The scenario that I just described is in the proposed regulations from the IRS but “proposed regulations” do not become law until the IRS issues final regulations. This is why we advised our clients to wait for the IRS to issue final regulations before applying this new RMD requirement to inherited retirement accounts subject to the 10-year rule.
The IRS initially said they anticipated issuing final regulations in the first half of 2023. Not only did that not happen, but they officially came out on July 14, 2023, and stated that they would not issue final regulations until at least 2024, which means non-spouse beneficiaries of retirement accounts subject to the 10-year rule will not face a penalty for not taking an RMD for 2023, regardless of when the decedent passed away.
Heading into 2024 we will once again have to wait and see if the IRS comes forward with the final regulations to implement the new RMDs rules outlined in their proposed regs.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Paying Tax On Inheritance?
Not all assets are treated the same tax wise when you inherit them. It’s important to know what the tax rules are and the distribution options that are available to you as a beneficiary of an estate. In this video we will cover the tax treatment on inheriting a:
· House
· Retirements Accounts
· Stock & Mutual Funds
· Life Insurance
· Annuities
· Trust Assets
We will also cover the:
· Distribution options available to spouse and non-spouse beneficiaries of retirement accounts
· Federal Estate Tax Limits
· Biden’s Proposed Changes To The Estate Tax Rules
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
New Rules For Non Spouse Beneficiaries Of Retirement Accounts Starting In 2020
The SECURE Act was signed into law on December 19, 2019 and with it comes some very important changes to the options that are available to non-spouse beneficiaries of IRA’s, 401(k), 403(b), and other types of retirement accounts
The SECURE Act was signed into law on December 19, 2019 and with it comes some very important changes to the options that are available to non-spouse beneficiaries of IRA’s, 401(k), 403(b), and other types of retirement accounts starting in 2020. Unfortunately, with the passing of this law, Congress took away one of the most valuable distribution options available to non-spouse beneficiaries called the “stretch” provision. Non-spouse beneficiaries would utilize this distribution option to avoid the tax hit associated with having to take big distributions from pre-tax retirement accounts in a single tax year. This article will cover:
The old inherited IRA rules vs. the new inherited IRA rules
The new “10 Year Rule”
Who is grandfathered in under the old inherited IRA rules?
Impact of the new rules on minor children beneficiaries
Tax traps awaiting non spouse beneficiaries of retirement accounts
The “Stretch” Option Is Gone
The SECURE Act’s elimination of the stretch provision will have a big impact on non-spouse beneficiaries. Prior to January 1, 2020, non-spouse beneficiaries that inherited retirement accounts had the option to either:
Take a full distribution of the retirement account within 5 years
Rollover the balance to an inherited IRA and stretch the distributions from the retirement account over their lifetime. Also known as the “stretch option”.
Since any money distributed from a pre-tax retirement account is taxable income to the beneficiary, many non-spouse beneficiaries would choose the stretch option to avoid the big tax hit associated with taking larger distributions from a retirement account in a single year. Under the old rules, if you did not move the money to an inherited IRA by December 31st of the year following the decedent’s death, you were forced to take out the full account balance within a 5 year period.
On the flip side, the stretch option allowed these beneficiaries to move the retirement account balance from the decedent’s retirement account into their own inherited IRA tax and penalty free. The non-spouse beneficiary was then only required to take small distributions each year from the account called a RMD (“required minimum distribution”) but was allowed to keep the retirement account intact and continuing to accumulate tax deferred over their lifetime. A huge benefit!
The New 10 Year Rule
For non-spouse beneficiaries, the stretch option was replaced with the “10 Year Rule” which states that the balance in the inherited retirement account needs to be fully distributed by the end of the 10th year following the decedent’s date of death. The loss of the stretch option will be problematic for non-spouse beneficiaries that inherit sizable retirement accounts because they will be forced to take larger distributions exposing those pre-tax distributions to higher tax rates.
No RMD Requirement Under The 10 Year Rule
Even though the stretch option has been lost, beneficiaries will have some flexibility as to the timing of when distributions will take place from their inherited IRA. Unlike the stretch provision that required the non-spouse beneficiary to start taking the RMD’s the year following the decedent’s date of death, there are no RMD requirements associated with the new 10 year rule. Meaning in extreme cases, the beneficiary could choose not to take any distributions from the retirement account for 9 years and then in year 10 distribute the full account balance.
Now, unless you love paying taxes, very few people would elect to distribute a large pre-tax retirement account balance in a single tax year but the new rules give you a decade to coordinate a distribution strategy that will help you to manage your tax liability under the new rules.
Tax Traps For Non-Spouse Beneficiaries
These new inherited IRA distribution rules are going to require pro-active tax and financial planning for the beneficiaries of these retirement accounts. I’m lumping financial planning into that mix because taking distributions from pre-tax retirement accounts increases your taxable income which could cause the following things to happen:
Reduce the amount of college financial aid that your child is receiving
Increase the amount of your social security that is considered taxable income
Loss of property tax credits such as the Enhanced STAR Program
Increase your Medicare Part B and Part D premiums the following year
You may phase out of certain tax credits or deductions that you were previously receiving
Eliminate your ability to contribute to a Roth IRA
Loss of Medicaid or Special Needs benefits
Ordinary income and capital gains taxed at a higher rate
You really have to plan out the next 10 years and determine from a tax and financial planning standpoint what is the most advantageous way to distribute the full balance of the inherited IRA to minimize the tax hit and avoid triggering an unexpected financial consequence associated with having additional income during that 10 year period.
Who Is Grandfathered In?
If you are the non-spouse beneficiary of a retirement account and the decedent passed away prior to January 1, 2020, you are grandfathered in under the old inherited IRA rules. Meaning you are still able to utilize the stretch provision. Here are a few examples:
Example 1: If you had a parent pass away in 2018 and in 2019 you rolled over their IRA into your own inherited IRA, you are not subject to the new 10 year rule. You are allowed to stretch the IRA distributions over your lifetime in the form of those RMD’s.
Example 2: On December 15, 2019, you father passed away and you are listed as the beneficiary on his 401(k) account. Since he passed away prior to January 1, 2020, you would still have the option of setting up an Inherited IRA prior to December 31, 2020 and then stretching the distributions over your lifetime.
Example 3: On February 3, 2020, your uncle passes away and you are listed as a beneficiary on his Rollover IRA. Since he passed away after January 1, 2020, you would be required to distribute the full IRA balance prior to December 31, 2030.
You are also grandfathered in under the old rules if:
The beneficiary is the spouse
Disabled beneficiaries
Chronically Ill beneficiaries
Individuals who are NOT more than 10 years younger than the decendent
Certain minor children (see below)
Even beyond 2020, the beneficiaries listed above will still have the option to rollover the balance into their own inherited IRA and then stretch the required minimum distributions over their lifetime.
Minor Children As Beneficiaries
The rules are slightly different if the beneficiary is the child of the decedent AND they are still a minor. I purposely capitalized the word “and”. Within the new law is a “Special Rule for Minor Children” section that states if the beneficiary is a child of the decedent but has not reached the age of majority, then the child will be able to take age-based RMD’s from the inherited IRA but only until they reach the age of majority. Once they are no longer a minor, they are required to distribute the remainder of the retirement account balance within 10 years.
Example: A mother and father pass away in a car accident and the beneficiaries listed on their retirement accounts are their two children, Jacob age 10, and Sarah age 8. Jacob and Sarah would be able to move the balances from their parent’s retirements accounts into an inherited IRA and then just take small required minimum distributions from the account based on their life expectancy until they reach age 18. In their state of New York, age 18 is the age of majority. The entire inherited IRA would then need to be fully distributed to them before the end of the calendar year of their 28th birthday.
This exception only applies if they are a child of the decedent. If a minor child inherits a retirement account from a non-parent, such as a grandparent, then they are immediately subject to the 10 year rule.
Note: the age of majority varies by state.
Plans Not Impacted Until January 1, 2022
The replacement of the stretch option with the new 10 Year Rule will impact most non-spouse beneficiaries in 2020. There are a few exceptions to that effective date:
403(b) & 457 plans sponsored by state and local governments, including Thrift Savings Plans sponsored by the Federal Government will not lose the stretch option until January 1, 2022
Plans maintained pursuant to a collective bargaining agreement also do not lose the stretch option until January 1, 2022
Advanced Planning
Under the old inherited IRA rules there was less urgency for immediate tax planning because the non-spouse beneficiaries just had to move the money into an inherited IRA the year after the decedent passed away and in most cases the RMD's were relatively small resulting in a minimal tax impact. For non-spouse beneficiaries that inherit a retirement account after January 1, 2020, it will be so important to have a tax plan and financial plan in place as soon as possible otherwise you could lose a lot of your inheritance to higher taxes or other negative consequences associated with having more income during those distribution years.
Please feel free to contact us if you have any questions on the new inherited IRA rules. We would also be more than happy to share with you some of the advanced tax strategies that we will be using with our clients to help them to minimize the tax impact of the new 10 year rule.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Understanding Required Minimum Distributions & Advanced Tax Strategies For RMD's
A required minimum distribution (RMD) is the amount that the IRS requires you to take out of your retirement account each year when you hit a certain age or when you inherit a retirement account from someone else. It’s important to plan tax-wise for these distributions because they can substantially increase your tax liability in a given year;
Understanding Required Minimum Distributions & Advanced Tax Strategies For RMD’s
A required minimum distribution (RMD) is the amount that the IRS requires you to take out of your retirement account each year when you hit a certain age or when you inherit a retirement account from someone else. It’s important to plan tax-wise for these distributions because they can substantially increase your tax liability in a given year; consequentially, not distributing the correct amount from your retirement accounts will invite huge tax penalties from the IRS. Luckily, there are advanced tax strategies that can be implemented to help reduce the tax impact of these distributions, as well as special situations that exempt you from having to take an RMD.
Age 72
LAW CHANGE: There were changes to the RMD age when the SECURE Act was passed into law on December 19, 2019. Prior to the law change, you were required to start taking RMD’s in the calendar year that you turned age 70 1/2. For anyone turning age 70 1/2 after December 31, 2019, their RMD start age is now delayed to age 72.
The most common form of required minimum distribution is age 72. In the calendar year that you turn 72, you are required to take your first distribution from your pretax retirement accounts.
The IRS has a special table called the “Uniform Lifetime Table”. There is one column for your age and another column titled “distribution period”. The way the table works is you find your age and then identify what your distribution period is. Below is the calculation step by step:
1) Determine your December 31 balance in your pre-tax retirement accounts for the previous year end
2) Find the distribution period on the IRS uniform lifetime table
3) Take your 12/31 balance and divide that by the distribution period
4) The previous step will result in the amount that you are required to take out of your retirement account by 12/31 of that year
Example: If you turn age 72 in March of 2023, you would be required to take your first RMD in that calednar year unless you elect the April 1st delay in the first year. After you find your age on the IRS uniform lifetime table, next to it you will see a distribution period of 25.6. The balance in your traditional IRA account on December 31, 2018 was $400,000, so your RMD would be calculated as follows:
$400,000 / 25.6 = $15,625
Your required minimum distribution amount for the 2023 tax year is $15,625. The first RMD will represent about 3.9% of the account balance, and that percentage will increase by a small amount each year.
RMD Deadline
There are very important dates that you need to be aware of once you reach age 72. In most years, you have to make your required minimum distribution prior to December 31 of that tax year. However, there is an exception for the year that you turn age 72. In the year that you turn 72, you have the option of taking your first RMD either prior to December 31 or April 1 of the following year. The April 1 exception only applies to the year that you turn 72. Every year after that first year, you are required to take your distribution by December 31st.
Delay to April 1st
So why would someone want to delay their first required minimum distribution to April 1? Since the distribution results in additional taxable income, it’s about determining which tax year is more favorable to realize the additional income.
For example, you may have worked for part of the year that you turned age 72 so you’re showing earned income for the year. If you take the distribution from your IRA prior to 12/31 that represents more income that you have to pay tax on which is stacked up on top of your earned income. It may be better from a tax standpoint to take the distribution in the following January because the amount distributed from your retirement account will be taxed in a year when you have less income.
Very important rule:
If you decide to delay your first required minimum distribution past 12/31, you will be required to take two RMD‘s in that following year.
Example: I retire from my company in September 2023 and I also turned 72 that same year. If I elect to take my first RMD on February 1, 2024, prior to the April 1 deadline, I will then be required to take a second distribution from my IRA prior to December 31, 2024.
If you are already retired in the year that you turn age 72 and your income level is going to be relatively the same between the current year and the following year, it often makes sense to take your first RMD prior to December 31st, so are not required to take two RMD‘s the following year which can subject those distributions to a higher tax rate and create other negative tax events.
IRS Penalty
If you fail to distribute the required amount by the given deadline, the IRS will be kind enough to assess a 50% penalty on the amount that you should have taken for your required minimum distribution. If you were required to take a $14,000 distribution and you failed to do so by the applicable deadline, the IRS will hit you with a $7,000 penalty. If you make the distribution, but the amount is not sufficient enough to meet the required minimum distribution amount, they will assess the 50% penalty on the shortfall instead. Bottom line, don’t miss the deadline.
Exceptions If You Are Still Working
There is an exception to the 72 RMD rule. If your only retirement asset is an employer sponsored retirement plan, such as a 401(k), 403(b), or 457, as long as you are still working for that employer, you are not required to take an RMD from that retirement account until after you have terminated from employment regardless of your age.
Example: You are age 73 and your only retirement asset is a 401(k) account with your current employer with a $100,000 balance, you will not be required to take an RMD from your 401(k) account in that year even though you are over the age of 72.
In the year that you terminate employment, however, you will be required to take an RMD for that year. For this reason, be very careful if you’re working over the age of 72 and leave employment in late December. Your retirement plan provider will have a very narrow window of time to process your required minimum distribution prior to the December 31st deadline.
This employer sponsored retirement plan exception only applies to balances in your current employer’s retirement plan. You do not receive this exception for retirement plan balances with previous employers.
If you have retirement account such as IRA’s or other retirement plan outside of your current employer’s plan, you will still be required to take RMD’s from those accounts, even though you are still working.
Advanced Tax Strategies
There are two advanced tax strategies that we use when individuals are age 72 and still working for a company that sponsors are qualified retirement plan.
It’s not uncommon for employees to have a retirement plans with their current employer, a rollover IRA, and some miscellaneous balance in retirement plans from former employers. Since you only have the exception to the RMD within your current employers plan, and most 401(k), 403(b), and 457 plans accept rollovers from IRAs and other qualified plans, it may be advantageous to complete rollovers of all those retirement accounts into your current employer’s plan so you can completely avoid the RMD requirement.
Strategy number two. If you are still working and you have access to an employer sponsored plan, you are usually able to make employee contributions pre-tax to the plan. If you are required to take a distribution from your IRA which results in taxable income, as long as you are not already maxing out your employee deferrals in your current employer’s plan, you can instruct payroll to increase your contributions to the plan to reduce your earned income by the amount of the required minimum distribution coming from your other retirement accounts.
Example: You are age 72 and working part time for an employer that gives you access to a 401(k) plan. Your 401(k) has a balance of $20,000 with that employer, but you also have a Rollover IRA with a balance of $200,000. In this case, you would not be required to take an RMD from your 401(k) balance, but you would be required to take an RMD from your IRA which would total approximately $7,500. Since the $7,500 will represent additional income to you in that tax year, you could turn around and instruct the payroll company to take 100% of your paychecks and put it pre-tax into your 401(k) account until you reach $7,500 which would wipe out the tax liability from the distribution that occurred from the IRA.
Or, if you have a spouse that still working and they have access to a qualified retirement plan, the same strategy can be implemented. Additionally, if you file a joint tax return, it doesn’t matter whose retirement plan it goes into because it’s all pre-tax at the end of the day.
5% or More Owner
Unfortunately, I have some bad news for business owners. If you are a 5% or more owner of the company, it does not matter whether or not you are still working for the company, you are required to take an RMD from the company’s employer sponsored retirement plan regardless. The IRS is well aware that the owner of the business could decide to work for two hours a week just to avoid required minimum distributions. Sorry entrepreneurs.
A Spouse That Is More Than 10 Years Younger
I mentioned above that the IRS has a uniform lifetime table for calculating the RMD amount. If your spouse is more than 10 years younger than you are, there is a special RMD table that you will need to use called the “joint life table” with a completely different set of distribution periods, so make sure you’re using the correct table when calculating the RMD amount.
Charitable contributions
There is also an advanced tax strategy that allows you to make contributions to charity directly from your IRA and you do not have to pay tax on those disbursements. The special charitable distributions from IRA’s are only allowed for individuals that are age 72 or older. If you regularly make contributions to a charity, church, or not for profit, or if you do not need the income from the RMD, this may be a great strategy to shelter what otherwise would have been more taxable income. There are a lot of special rules surrounding how these charitable contributions work. For more information on this strategy see the following article:
Lower Your Tax Bill By Directing Your Mandatory IRA Distributions To Charity
Roth IRA’s
You are not required to take RMD‘s from Roth IRA accounts at age 72, this is one of the biggest tax advantages of Roth IRAs.
Inherited IRA
When you inherit an IRA from someone else, those IRAs have their own set of required minimum distribution rules which vary from the rules at the age 72. The SECURE Act that was passed in 2019 split non-spouse beneficiaries of IRA into two categories. For individuals that inherited retirement accounts prior to December 31, 2019, they are still able to stretch the RMD over their lifetime and the required minimum distributions must begin by December 31st of the year following the decedent date of death. For individuals that inherited a retirement account after December 31, 2019, the New 10 Rule replaced the stretch option and no RMDs are required for non-spouse beneficiaries. For the full list of rule, deadlines, and tax strategies surrounding inherited IRA’s see the articles listed below:
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Advanced Tax Strategies For Inherited IRA's
Inherited IRA’s can be tricky. There are a lot of rules surrounding;
Establishment and required minimum distribution (“RMD”) deadlines
Options available to spouse and non-spouse beneficiaries
Strategies for deferring required minimum distributions
Special 60 day rollover rules for inherited IRA’s
Inherited IRA’s can be tricky. There are a lot of rules surrounding;
Establishment and required minimum distribution (“RMD”) deadlines
Options available to spouse and non-spouse beneficiaries
Strategies for deferring required minimum distributions
Special 60 day rollover rules for inherited IRA’s
Establishment Deadline
If the decedent passed away prior to December 31, 2019, as a non-spouse beneficiary you have until December 31st of the year following the decedent’s death to establish an inherited IRA, rollover the balance into that IRA, and begin taking RMD’s based your life expectancy. If you miss that deadline, you are locked into distribution the full balance with a 10 year period.
If the decedent passed away January 1, 2020 or later, with limited exceptions, the inherited IRA rollover option with the stretch option is no longer available to non-spouse beneficiaries.
RMD Deadline - Decedent Passed Away Prior to 12/31/19
If you successfully establish an inherited IRA by the December 31st deadline, if you are non-spouse beneficiary, you will be required to start taking a “required minimum distribution” based on your own life expectancy in the calendar year following the decedent’s date of death.
Here is the most common RMD mistake that is made. The beneficiary forgets to take an RMD from the IRA in the year that the decedent passes away. If someone passes away toward the beginning of the year, there is a high likelihood that they did not take the RMD out of their IRA for that year. They are required to do so and the RMD amount is based on what the decedent was required to take for that calendar year, not based on the life expectancy of the beneficiary. A lot of investment providers miss this and a lot of beneficiaries don’t know to ask this question. The penalty? A lovely 50% excise tax by the IRS on the amount that should have been taken.
Distribution Options Available To A Spouse
If you are the spouse of the decedent you have three distribution options available to you:
Take a cash distribution
Rollover the balance to your own IRA
Rollover the balance to an Inherited IRA
Cash distributions are treated the same whether you are a spouse or non-spouse beneficiary. You incur income tax on the amounts distributed but you do not incur the 10% early withdrawal penalty regardless of age because it’s considered a “death distribution”. For example, if the beneficiary is 50, normally if distributions are taken from a retirement account, they get hit with a 10% early withdrawal penalty for not being over the age of 59½. For death distributions to beneficiaries, that 10% penalty is waived.
#1 Mistake Made By Spouse Beneficiaries
This exemption of the 10% early withdrawal penalty leads me to the number one mistake that we see spouses make when choosing from the three distribution options listed above. The spouse has a distribution option that is not available to non-spouse beneficiaries which is the ability to rollover the balance to their own IRA. While this is typically viewed as the easiest option, in many cases, it is not the most ideal option. If the spouse is under 59½, they rollover the balance to their own IRA, if for whatever reason they need to access the funds in that IRA, they will get hit with income taxes AND the 10% early withdrawal penalty because it’s now considered an “early distribution” from their own IRA.
Myth: Spouse Beneficiaries Have To Take RMD’s From Inherited IRA’s
Most spouse beneficiaries make the mistake of thinking that by rolling over the balance to their own IRA instead of an Inherited IRA they can avoid the annual RMD requirement. However, unlike non-spouse beneficiaries which are required to take taxable distributions each year, if you are the spouse of the decedent you do not have to take RMD’s from the inherited IRA unless your spouse would have been age 70 ½ if they were still alive. Wait…..what?
Let me explain. Let’s say there is a husband age 50 and a wife age 45. The husband passes away and the wife is the sole beneficiary of his retirement accounts. If the wife rolls over the balance to an Inherited IRA, she will avoid taxes and penalties on the distribution, and she will not be required to take RMD’s from the inherited IRA for 20 years, which is the year that their deceased spouse would have turned age 70 ½. This gives the wife access to the IRA if needed prior to age 59 ½ without incurring the 10% penalty.
Wait, It Gets Better......
But wait, since the wife was 5 years young than the husband, wouldn’t she have to start taking RMD’s 5 years sooner than if she just rolled over the balance to her own IRA? If she keeps the balance in the Inherited IRA the answer is “Yes” but here is an IRA secret. At any time, a spouse beneficiary is allowed to rollover the balance in their inherited IRA to their own IRA. So in the example above, the wife in year 19 could rollover the balance in the inherited IRA to her own IRA and avoid having to take RMD’s until she reaches age 70½. The best of both worlds.
Spouse Beneficiary Over Age 59½
If the spouse beneficiary is over the age of 59½ or you know with 100% certainty that the spouse will not need to access the IRA assets prior to age 59 ½ then you can simplify this process and just have them rollover the balance to their own IRA. The 10% early withdrawal penalty will never be an issue.
Non-Spouse Beneficiary Options
As mentioned above, the distribution options available to non-spouse beneficiaries were greatly limited after the passing of the SECURE ACT by Congress on December 19, 2019. For most individuals that inherit retirement accounts after December 31, 2019, they will now be subject to the new "10 Year Rule" which requires non-spouse beneficiary to completely deplete the retirement account 10 years following the year of the decedents death.
For more on the this change and the options available to Non-Spouse beneficiaries in years 2020 and beyond, please read the article below:
60 Day Rollover Mistake
There is a 60 day rollover rule that allows the owner of an IRA to take a distribution from an IRA and if the money is deposited back into the IRA within 60 days, it’s like the distribution never happened. Each taxpayer is allowed one 60 day rollover in a 12 month period. Think of it as a 60 day interest free loan to yourself.
Inherited IRA’s are not eligible for 60 day rollovers. If money is distributed from the Inherited IRA, the rollover back into the IRA will be disallowed, and the individual will have to pay taxes on the amount distributed.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
